SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

ý        QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES

EXCHANGE ACT OF 1934.

 

For the quarterly period ended March 31, 2004

 

OR

 

o        TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES

EXCHANGE ACT OF 1934

 

For the transition period from                       to                         .

 

Commission file number 1-13661

 

S. Y. BANCORP, INC.

(Exact name of registrant as specified in its charter)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes  ý  No  o

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).

Yes  ý  No  o

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

Common Stock, no par value – 13,743,607

shares issued and outstanding at May 3, 2004

 

 

PART I - FINANCIAL INFORMATION

 

Item 1.  Financial Statements

 

The following consolidated financial statements of S.Y. Bancorp, Inc. and Subsidiary, Stock Yards Bank & Trust Company, are submitted herewith:

 

–		Unaudited Condensed Consolidated Balance Sheets March 31, 2004 and December 31, 2003
–		Unaudited Condensed Consolidated Statements of Income for the three months ended March 31, 2004 and 2003
–		Unaudited Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2004 and 2003
–		Unaudited Condensed Consolidated Statement of Changes in Stockholders’ Equity for the three months ended March 31, 2004
–		Unaudited Condensed Consolidated Statement of Comprehensive Income for the three months ended March 31, 2004 and 2003
–		Notes to Unaudited Condensed Consolidated Financial Statements

 

 

S.Y. BANCORP, INC. AND SUBSIDIARY

Unaudited Condensed Consolidated Balance Sheets

March 31, 2004 and December 31, 2003

(In thousands, except share data)

 

		March 31, 2004			December 31, 2003
Assets
Cash and due from banks		$	30,104		31,911
Federal funds sold		12,194			2,165
Mortgage loans held for sale		5,723			3,157
Securities available for sale (amortized cost of $151,255 in 2004 and $152,951 in 2003)		154,987			155,691
Securities held to maturity (approximate fair value of $5,902 in 2004 and $6,244 in 2003)		5,580			5,915
Loans		893,370			886,153
Less allowance for loan losses		12,084			11,798
Net loans		881,286			874,355
Premises and equipment, net		25,028			24,785
Accrued interest receivable and other assets		19,861			20,542
Total assets		$	1,134,763		1,118,521
Liabilities and Stockholders’ Equity
Deposits:
Non-interest bearing		$	152,818		143,901
Interest bearing		733,808			737,965
Total deposits		886,626			881,866
Securities sold under agreements to repurchase and federal funds purchased		70,337			92,102
Other short-term borrowings		409			1,232
Accrued interest payable and other liabilities		20,196			22,078
Federal home loan bank advances		30,000			—
Subordinated debentures		20,799			20,829
Total liabilities		1,028,367			1,018,107
Stockholders’ equity:
Preferred stock, no par value; 1,000,000 shares authorized; no shares issued or outstanding		—			—
Common stock, no par value; 20,000,000 shares authorized; 13,735,967 and 13,575,316 shares issued and outstanding in 2004 and 2003, respectively		6,612			6,128
Surplus		17,657			16,153
Retained earnings		80,009			76,659
Accumulated other comprehensive income		2,118			1,474
Total stockholders’ equity		106,396			100,414
Total liabilities and stockholders’ equity		$	1,134,763		1,118,521

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

2

 

S.Y. BANCORP, INC. AND SUBSIDIARY

Unaudited Condensed Consolidated Statements of Income

For the three months ended March 31, 2004 and 2003

(In thousands, except share and per share data)

 

		2004			2003
Interest income:
Loans		$	13,331		13,557
Federal funds sold		24			95
Mortgage loans held for sale		39			216
Securities - taxable		1,039			882
Securities - tax-exempt		358			261
Total interest income		14,791			15,011
Interest expense:
Deposits		3,111			4,017
Securities sold under agreements to repurchase and federal funds purchased		199			167
Other short-term borrowings		2			2
Long-term debt		63			—
Subordinated debentures		466			452
Total interest expense		3,841			4,638
Net interest income		10,950			10,373
Provision for loan losses		500			700
Net interest income after provision for loan losses		10,450			9,673
Non-interest income:
Investment management and trust services		2,214			2,026
Service charges on deposit accounts		2,125			1,899
Bankcard transaction revenue		233			248
Gains on sales of mortgage loans held for sale		234			597
Brokerage commissions and fees		438			264
Other		443			475
Total non-interest income		5,687			5,509
Non-interest expenses:
Salaries and employee benefits		5,602			5,230
Net occupancy expense		706			572
Data processing expense		850			868
Furniture and equipment expense		270			232
State bank taxes		281			278
Other		1,889			1,899
Total non-interest expenses		9,598			9,079
Income before income taxes		6,539			6,103
Income tax expense		2,091			1,974
Net income		$	4,448		4,129
Net income per share:
Basic		$	0.33		0.31
Diluted		$	0.32		0.30
Average common shares:
Basic		13,608,495			13,431,597
Diluted		14,110,731			13,934,920

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

3

 

S.Y. BANCORP, INC. AND SUBSIDIARY

Unaudited Condensed Consolidated Statements of Cash Flows

For the three months ended March 31, 2004 and 2003

(In thousands)

 

		2004			2003
Operating activities:
Net income		$	4,448		4,129
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses		500			700
Depreciation, amortization and accretion, net		736			643
Gains on sales of mortgage loans held for sale		(234		)	(597	)
Origination of mortgage loans held for sale		(45,246		)	(106,649	)
Proceeds from sale of mortgage loans held for sale		42,914			118,328
Loss (gain) on the sale of other real estate		7			(5	)
Income tax benefit of stock options exercised		268			286
Increase (decrease) in accrued interest receivable and other assets		36			(1,066	)
Increase in accrued interest payable and other liabilities		(1,895		)	(129	)
Net cash provided by operating activities		1,534			15,640
Investing activities:
Net increase in federal funds sold		(10,029		)	(48,845	)
Purchases of securities available for sale		(37,162		)	(12,638	)
Proceeds from maturities of securities available for sale		38,825			29,274
Proceeds from maturities of securities held to maturity		335			2,008
Net increase in loans		(7,269		)	(16,818	)
Purchases of premises and equipment		(946		)	(1,432	)
Proceeds from sales of other real estate		128			364
Net cash used by investing activities		(16,118		)	(48,087	)
Financing activities:
Net increase in deposits		4,760			35,601
Net decrease in securities sold under agreements to repurchase and federal funds purchased		(21,765		)	(1,785	)
Net decrease in other short-term borrowings		(823		)	(2,601	)
Net proceeds of long-term debt		30,000			—
Repayments of subordinated debentures		(30		)	(30	)
Issuance of common stock for options and dividend reinvestment plan		1,720			352
Common stock repurchases		—			(41	)
Cash dividends paid		(1,085		)	(940	)
Net cash provided by financing activities		12,777			30,556
Net decrease in cash and cash equivalents		(1,807		)	(1,891	)
Cash and cash equivalents at beginning of period		31,911			34,918
Cash and cash equivalents at end of period		$	30,104		33,027
Supplemental cash flow information:
Income tax payments		$	—		—
Cash paid for interest		$	3,770		4,720

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

4

 

S.Y. BANCORP, INC. AND SUBSIDIARY

Unaudited Condensed Consolidated Statement of Changes in Stockholders’ Equity

For the three months ended March 31, 2004

(In thousands, except share and per share data)

 

							Surplus			Retained Earnings			Accumulated Other Comprehensive Income			Total
		Common Stock
		Number of Shares		Amount
Balance December 31, 2003		13,575,316		$	6,128		$	16,153		$	76,659		$	1,474		$	100,414
Net income		—		—			—			4,448			—			4,448
Change in other comprehensive income, net of tax		—		—			—			—			644			644
Shares issued for stock options exercised and employee benefit plans		160,651		484			1,504			—			—			1,988
Cash dividends, $0.08 per share		—		—			—			(1,098		)	—			(1,098		)
Balance March 31, 2004		13,735,967		$	6,612		$	17,657		$	80,009		$	2,118		$	106,396

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

5

 

S.Y. BANCORP, INC. AND SUBSIDIARY

Unaudited Condensed Consolidated Statements of Comprehensive Income

For the three months ended March 31, 2004 and 2003

(In thousands)

 

		2004			2003
Net income		$	4,448		4,129
Other comprehensive income, net of tax:
Unrealized holding gains (losses) on securities available for sale arising during the period		644			(231	)
Other comprehensive income (loss)		644			(231	)
Comprehensive income		$	5,092		3,898

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

6

 

S.Y. BANCORP, INC. AND SUBSIDIARY

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

(1)           Summary of Significant Accounting Policies

 

The accompanying unaudited consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and do not include all information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements.  The consolidated financial statements of S.Y. Bancorp, Inc. (Bancorp) and its subsidiary reflect all adjustments (consisting only of adjustments of a normal recurring nature) which are, in the opinion of management, necessary for a fair presentation of financial condition and results of operations for the interim periods.

 

The unaudited consolidated financial statements include the accounts of S.Y. Bancorp, Inc. and its wholly-owned subsidiary, Stock Yards Bank & Trust Company (Bank).  All significant intercompany transactions have been eliminated in consolidation.  Bancorp also owns S.Y. Bancorp Capital Trust I (Trust), a Delaware statutory business trust that is a 100% owned finance subsidiary.  Due to a recent accounting pronouncement, the Trust is no longer consolidated in the consolidated financial statements of Bancorp.  See note 4 to the consolidated financial statements below for more information on the Trust.

 

A description of other significant accounting policies is presented in the notes to the Consolidated Financial Statements for the year ended December 31, 2003 included in S.Y. Bancorp, Inc.’s Annual Report on Form 10-K for the year then ended.

 

Interim results for the quarter ended March 31, 2004 are not necessarily indicative of the results for the entire year.

 

All common stock share and per share information has been restated to reflect the September 2003 two for one stock split.

 

Critical Accounting Policies

 

Management has identified the accounting policy related to the allowance for loan losses as critical to the understanding of Bancorp’s results of operations and discussed this conclusion with the Audit Committee of the board of directors.  Since the application of this policy requires significant management assumptions and estimates, it could result in materially different amounts to be reported if conditions or underlying circumstances were to change.  The accounting policy related to the allowance for loan losses is applicable to the commercial and retail banking segment of Bancorp.

 

Stock-Based Compensation

 

As permitted by Statement of Financial Accounting Standards (SFAS) No. 148, “ Accounting for Stock-Based Compensation – Transition and Disclosure, an amendment of FASB Statement No. 123,” Bancorp will continue to apply the provisions of Accounting Principles Board Opinion No. 25, “Accounting for Stock-Based Compensation,” for all stock option grants and has elected to disclose pro forma net income and earnings per share amounts as if the fair-value based method had been applied in measuring compensation costs.

 

No stock based compensation is reflected in net income because all options granted under the current stock incentive plan have an exercise price equal to the market price of Bancorp’s stock at the grant date.  Bancorp discloses proforma net income and earnings per share in the notes to its consolidated financial statements as if compensation were measured at the date of grant based on the fair value of the award and recognized over the service period.

 

7

 

Bancorp’s as reported and proforma earnings per share information for the three months ended March 31 follows:

 

		Three Months Ended March 31
(In thousands, except per share data)		2004			2003
Net income, as reported		$	4,448		$	4,129
Less: stock-based compensation expense determined under fair value method, net of tax		65			54
Proforma net income		$	4,383		$	4,075
Basic EPS:
As reported		$	0.33		$	0.31
Proforma		0.32			0.30
Diluted EPS:
As reported		0.32			0.30
Proforma		0.31			0.29

 

No options were granted in the first quarter of 2004.

 

(2)           Allowance for Loan Losses

 

An analysis of the changes in the allowance for loan losses for the three months ended March 31 follows:

 

(In thousands)		2004			2003
Beginning balance		$	11,798		11,705
Provision for loan losses		500			700
Loans charged off		(485		)	(688	)
Recoveries		271			282
Ending balance		$	12,084		11,999

 

(3)           Federal Home Loan Bank Advances

 

Under a blanket collateral agreement with the Federal Home Loan Bank of Cincinnati and secured by certain residential real estate loans, the Bank borrowed funds via three separate fixed rate, non-callable advances of $10,000,000 each in the first quarter of 2004.  The advances have terms of one, two and three years, respectively with a weighted average rate of 2.14%.  Interest payments are due monthly, with principal due at maturity.

 

(4)           Subordinated Debentures

 

On June 1, 2001, S.Y. Bancorp Capital Trust I (Trust), a Delaware statutory business trust and 100%-owned finance subsidiary of Bancorp, issued $20.0 million of 9.00% Cumulative Trust Preferred Securities (Securities) which will mature on June 30, 2031, but prior redemption is permitted under certain circumstances, such as changes in tax or regulatory capital rules.  The principal asset of S.Y. Bancorp Capital Trust I is a $20.0 million subordinated debenture of Bancorp.  The subordinated debenture bears interest at the rate of 9.00% and matures

 

8

 

June 30, 2031, subject to prior redemption under certain circumstances.  Bancorp owns all of the common securities of the Trust.

 

The Securities, the assets of the Trust, and the common securities issued by the Trust are redeemable in whole or in part on or after June 30, 2006, or at any time in whole, but not in part, from the date of issuance upon the occurrence of certain events.  The Securities are included in Tier 1 capital for regulatory capital adequacy determination purposes, subject to certain limitations.

 

The obligations of Bancorp with respect to the issuance of the Securities constitute a full and unconditional  guarantee by Bancorp of the Trust’s obligation with respect to the Securities.

 

Subject to certain exceptions and limitations, Bancorp may, from time to time, defer subordinated debenture interest payments, which would result in a deferral of distribution payments on the related Securities and, with certain exceptions, prevent Bancorp from declaring or paying cash distributions on Bancorp’s common stock or debt securities that rank pari passu or junior to the subordinated debenture.

 

Prior to 2003, the Trust was consolidated in Bancorp’s financial statements, with the trust preferred securities issued by the Trust reported in liabilities as “Long Term Debt – Trust Preferred Securities” and the subordinated debentures eliminated in consolidation.  Under new accounting guidance, FASB Interpretation No. 46, as revised in December 2003, the Trust is no longer consolidated with Bancorp.  Accordingly, Bancorp does not report the securities issued by the Trust as liabilities, and instead reports as liabilities the subordinated debentures issued by Bancorp and held by the Trust, as these are no longer eliminated in consolidation.  The amount of the subordinated debentures as of March 31, 2004 and December 31, 2003 was $20,619,000.  In applying this FASB Interpretation, Bancorp recorded the investment in the common securities issued by the Trust and a corresponding obligation of the Trust’s subordinated debentures as well as interest income and interest expense on this investment and obligation.  The application of this FASB Interpretation has been reflected in all applicable prior periods.

 

The Bank also had 3.00% subordinated debentures outstanding amounting to $180,000 at March 31, 2004 and $210,000 at December 31, 2003. Interest due on these debentures is at a variable rate equal to one percent less than the Bank’s prime rate adjusted annually on January 1. For 2003, the rate on these debentures was 3.25%. The debentures are subordinated to the claims of creditors and depositors of the Bank and are subject to redemption by the Bank at the principal amount outstanding, upon the earlier of the death of the registered owners, or an event of default by the registered owners with respect to loans from the Bank.  While the debentures mature in 2049, the owners may redeem the debentures at any time.

 

(5)           Intangible Assets

 

Statement of Financial Accounting Standards No. 142, “Goodwill and Intangible Assets” (“SFAS No. 142”), requires that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead be tested for impairment at least annually.  Bancorp currently has unamortized goodwill remaining from the acquisition of a bank in southern Indiana in the amount of $682,000.  This goodwill is assigned to the commercial and retail banking segment of Bancorp.

 

9

 

(6)           Defined Benefit Retirement Plan

 

The Bank sponsors an unfunded, non-qualified, defined benefit retirement plan for certain key officers.  Benefits vest based on years of service.  Information about the components of the net periodic benefit cost of the defined benefit plan follows:

 

		Three Months Ended March 31,
(Dollars in thousands)		2004			2003
Components of net periodic benefit cost:
Service cost		$	—		$	—
Interest cost		30			30
Expected return on plan assets		—			—
Amortization of prior service cost		2			2
Amortization of the net (gain) loss		8			6
Net periodic benefit cost		$	40		$	38

 

(7)           Commitments to Extend Credit

 

As of March 31, 2004, Bancorp had various commitments outstanding that arose in the normal course of business, such as standby letters of credit and commitments to extend credit, which are properly not reflected in the consolidated financial statements. In management’s opinion, commitments to extend credit of $208,870,000, including standby letters of credit of $14,959,000, represent normal banking transactions, and no significant losses are anticipated to result therefrom as of March 31, 2004. Commitments to extend credit were $198,907,000, including letters of credit of $11,854,000, as of December 31, 2003.  Bancorp’s exposure to credit loss in the event of nonperformance by the other party to these commitments is represented by the contractual amount of these instruments. Bancorp uses the same credit and collateral policies in making commitments and conditional guarantees as for on-balance sheet instruments.

 

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Bancorp evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by Bancorp upon extension of credit, is based on management’s credit evaluation of the customer. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment, and income-producing commercial properties.

 

Standby letters of credit and financial guarantees written are conditional commitments issued by Bancorp to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support private borrowing arrangements.

 

10

 

(8)           Preferred Stock

 

At Bancorp’s annual meeting of shareholders held in April 2003, the shareholders approved an amendment to the Articles of Incorporation to create a class of preferred stock and authorize 1,000,000 shares of this preferred stock.  The relative rights, preferences and other terms of this stock or any series within the class will be determined by the Board of Directors prior to any issuance.  Some of this preferred stock will be used in connection with a shareholders’ rights plan upon the occurrence of certain triggering events.  None of this stock has been issued as of March 31, 2004.

 

(9)           Net Income Per Share

 

The following table reflects, for the quarter ended March 31, 2004 and 2003, net income (the numerator) and average shares outstanding (the denominator) for the basic and diluted net income per share computations (in thousands except per share data):

 

		Three Months Ended March 31
		2004			2003
Net income, basic and diluted		$	4,448		4,129
Average shares outstanding		13,608			13,432
Effect of dilutive securities		503			503
Average shares outstanding including dilutive securities		14,111			13,935
Net income per share, basic		$	0.33		0.31
Net income per share, diluted		$	0.32		0.30

 

11

 

(10)         Segments

 

The Bank’s, and thus Bancorp’s, principal activities include commercial and retail banking, investment management and trust, and mortgage banking.  Commercial and retail banking provides a full range of loans and deposit products to individual consumers and businesses.  Investment management and trust provides wealth management services including brokerage, estate planning and administration, retirement plan management, and custodian or trustee services. Mortgage banking originates residential loans and sells them, servicing released, in the secondary market.

 

The financial information for each business segment reflects that which is specifically identifiable or allocated based on an internal allocation method.  The measurement of the performance of the business segments is based on the management structure of the Bank and is not necessarily comparable with similar information for any other financial institution.  The information presented is also not necessarily indicative of the segments’ operations, if they were independent entities.

 

Selected financial information by business segment for the quarter ended March 31, 2004 and 2003 follows:

 

		Three Months Ended March 31
(In thousands)		2004			2003
Net interest income:
Commercial and retail banking		$	10,651		10,167
Investment management and trust		209			5
Mortgage banking		90			201
Total		$	10,950		10,373
Non-interest income:
Commercial and retail banking		$	2,690		2,320
Investment management and trust		2,652			2,329
Mortgage banking		345			860
Total		$	5,687		5,509
Net income:
Commercial and retail banking		$	3,767		3,215
Investment management and trust		695			611
Mortgage banking		(14		)	303
Total		$	4,448		4,129

 

Principally, all of the net assets of S.Y. Bancorp, Inc. are involved in the commercial and retail banking segment.

 

12

 

Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

This item discusses the results of operations for S.Y. Bancorp, Inc. (Bancorp), and its subsidiary, Stock Yards Bank & Trust Company for the three months ended March 31, 2004 and compares that period with the same period of the previous year.  Unless otherwise indicated, all references in this discussion to the “Bank” include Bancorp.  In addition, the discussion describes the significant changes in the financial condition of Bancorp and the Bank that have occurred during the first quarter of 2004 compared to December 31, 2003.  This discussion should be read in conjunction with the unaudited consolidated financial statements and accompanying notes presented in Part I, Item 1 of this report.

 

This report contains forward-looking statements under the Private Securities Litigation Reform Act that involve risks and uncertainties.  Although Bancorp believes the assumptions underlying the forward-looking statements contained herein are reasonable, any of these assumptions could be inaccurate.  Factors that could cause actual results to differ from results discussed in forward-looking statements include, but are not limited to the following: economic conditions both generally and more specifically in the market in which Bancorp and its subsidiaries operate; competition for Bancorp’s customers from other providers of financial services; government legislation and regulation which change from time to time and over which Bancorp has no control; changes in interest rates; material unforeseen changes in liquidity, results of operations, or financial condition of Bancorp’s customers; other risks detailed in Bancorp’s filings with the Securities and Exchange Commission, all of which are difficult to predict and many of which are beyond the control of Bancorp.

 

Overview of First Quarter 2004

 

As is the case with most banks, the primary source of Bancorp’s revenue is net interest income and fees from various financial services provided to customers.  Net interest income is the difference between interest income earned on loans, investment securities and other interest earning assets less interest expense on deposit accounts and other interest bearing liabilities.  Loan volume and the interest rates earned on those loans are critical to overall profitability. Similarly deposit volume is crucial to funding loans, and the rates on those deposits directly impacts profitability. Business volumes are influenced by overall economic factors including market interest rates, business spending, consumer confidence and competitive conditions within the marketplace.

 

The first quarter of 2004 continued to be a challenging business environment in many respects, characterized by economic uncertainty, consumer apprehension and pressure on net interest spread and margin created by a continuation of record low interest rates.  The low interest rate environment had an unfavorable effect on Bancorp’s net interest income as rates on interest bearing assets continued to fall, while rates on many interest bearing liabilities approached zero percent.  Despite these obstacles, Bancorp completed a quarter with net income exceeding the comparable quarter of 2003 by 8%. This represents the beginning of the Company’s seventeenth consecutive year of higher earnings; however, this growth is at a somewhat slower rate since the prior eleven years have produced double-digit growth in earnings.

 

Slower than desired business loan growth continued into 2004. Customers were cautious and limited their draws on established lines of credit. Consumer loans grew modestly in 2004. Company management has not pursued time deposits aggressively as the need to fund loan growth has slowed.

 

Bancorp has a higher than average proportion of non-interest revenues which, in addition to net interest income, have proven to fuel net income growth. While total non-interest income grew only slightly in the first quarter of 2004 as compared to the same period of 2003, declines in gains on sales of mortgage loans were offset by increasing fees from other sources including investment management and trust fees, service charges on deposit accounts and brokerage revenues.

 

13

 

Results in 2004 were positively affected by a lower provision for loan losses.  Internal loan quality measurements were at their best levels in three years and there was an overall decline in non-performing loans and net charge-offs quarter to quarter.  Bancorp’s process of evaluating the inherent risk in the portfolio considered this data and other information in the evaluation of the risk in the loan portfolio to determine the required balance in the allowance for loan losses account.

 

The following sections will provide more details on subjects presented in this overview.

 

(a)         Results Of Operations

 

Net income of $4,448,000 for the three months ended March 31, 2004 increased $319,000 or 7.7% from $4,129,000 for the comparable 2003 period.  Basic net income per share was $0.33 for the first quarter of 2004, an increase of 6.5% from the $0.31 for the same period in 2003.  Net income per share on a diluted basis was $0.32 for the first quarter of 2004 compared to $0.30 for the first quarter of 2003.  This represents a 6.7% increase.  Annualized return on average assets and annualized return on average stockholders’ equity were 1.61% and 17.26%, respectively, for the first quarter of 2004, compared to 1.60% and 18.92%, respectively, for the same period in 2003.

 

14

 

The following paragraphs provide a more detailed analysis of the significant factors affecting operating results and financial condition.

 

Net Interest Income

 

		Three Months Ended March 31
(Dollars in thousands)		2004		2003
Interest income		$14,791		15,011
Tax equivalent adjustment		215		174
Interest income, tax equivalent basis		15,006		15,185
Total interest expense		3,841		4,638
Net interest income, tax equivalent basis (1)		$11,165		10,547
Net interest spread (2), annualized		3.93	%	3.91	%
Net interest margin (3), annualized		4.29	%	4.33	%

 

Notes:

 

(1)                Net interest income, the most significant component of the Bank’s earnings, is total interest income less total interest expense.  The level of net interest income is determined by the mix and volume of interest earning assets, interest bearing deposits and borrowed funds, and by changes in interest rates.

 

(2)                Net interest spread is the difference between the taxable equivalent rate earned on interest earning assets less the rate expensed on interest bearing liabilities.

 

(3)                Net interest margin represents net interest income on a taxable equivalent basis as a percentage of average interest earning assets.  Net interest margin is affected by both the interest rate spread and the level of non-interest bearing sources of funds, primarily consisting of demand deposits and stockholders’ equity.

 

Fully taxable equivalent net interest income of $11,165,000 for the three months ended March 31, 2004 increased $618,000 or 5.9% from $10,547,000 when compared to the same period last year. Net interest spread and net interest margin were 3.93% and 4.29%, respectively, for the first quarter of 2004 and 3.91% and 4.33%, respectively, for the first quarter of 2003.  The decrease in net interest margin for the quarter can be attributed to the decline in rates on earning assets that were partially offset by declines in rates on interest bearing liabilities.  As higher yielding loans and investment securities mature or pay off, we have replaced them with lower yielding instruments.  Similarly, maturities of higher priced time deposits have lowered interest expense on deposits.  Management expects continued margin contraction during 2004 as rates on interest earning assets are projected to decline further with limited ability to further lower interest costs.  Margin contraction could range from five to ten basis points depending on such factors as competitive rate pressures or unforeseen changes in the Bank’s funding mix.  This estimate does not include effects from any interest rate changes by the Federal Reserve.

 

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Average earning assets increased $58,785,000, or 5.9% to $1,047,674,000 for the first three months of 2004 compared to 2003, reflecting growth in the loan and investment portfolios.  Average interest bearing liabilities increased $31,837,000 or 3.9% to $842,813,000 for the first three months of 2004 compared to 2003 primarily due to increases in interest bearing transaction deposits and borrowings from the Federal Home Loan Bank.

 

Managing interest rate risk is fundamental for the financial services industry. The primary objective of interest rate risk management is to neutralize effects of interest rate changes on net income.  Bank management evaluates interest rate sensitivity while attempting to optimize net interest income within the constraints of prudent capital adequacy, liquidity needs, market opportunities and customer requirements.

 

Bancorp uses an earnings simulation model to estimate and evaluate the impact of changing interest rates on earnings. The simulation model is designed to reflect the dynamics of interest earning assets, interest bearing liabilities and off-balance sheet financial instruments, in a one year forecast. By estimating the effects of interest rate increases and decreases, the model can reveal approximate interest rate risk exposure. The simulation model is used by management to gauge approximate results given a specific change in interest rates at a given point in time.  The model is therefore a tool to indicate earnings trends in given interest rate scenarios and does not indicate actual expected results.  The March 31, 2004 simulation analysis indicates that an increase in interest rates would have a positive effect on net interest income, and a decrease in interest rates would have a negative effect on net interest income.  These estimates are summarized below.

 

Interest Rate Simulation Sensitivity Analysis

 

		Net Interest Income Change
Increase 200bp		12.09	%
Increase 100bp		6.04
Decrease 100bp		(6.07	)
Decrease 200bp		(14.04	)

 

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Provision for Loan Losses

 

The allowance for loan losses is based on management’s continuing review of individual credits, loss experience, current economic conditions, the risk characteristics of the various categories of loans, and such other factors that, in management’s judgment, deserve current recognition in estimating loan losses.

 

An analysis of the changes in the allowance for loan losses and selected ratios follows:

 

		Three Months Ended March 31
(Dollars in thousands)		2004			2003
Balance at the beginning of the period		$	11,798		11,705
Provision for loan losses		500			700
Loan charge-offs, net of recoveries		(214		)	(406	)
Balance at the end of the period		$	12,084		11,999
Average loans, net of unearned income		$	889,672		832,979
Provision for loan losses to average loans (1)		0.06		%	0.08	%
Net loan charge-offs to average loans (1)		0.02		%	0.05	%
Allowance for loan losses to average loans		1.36		%	1.44	%
Allowance for loan losses to period-end loans		1.35		%	1.44	%

 

(1) Amounts not annualized

 

The provision for loan losses declined 28.6% in 2004 as compared to 2003 in consideration of several factors, all of which estimate the level of inherent risk in the loan portfolio.  The credit quality of the Bank’s loan portfolio showed improvement during the first quarter of 2004 as internal loan quality metrics including loss experience and information about specific borrower situations were at their best levels in several quarters.  Non-performing loans declined $1.1 million to $4.3 million as of March 31, 2004 as compared to the same period one year ago.  Management considers the allowance for loan losses adequate to cover losses inherent in the loan portfolio.

 

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Non-interest Income and Expenses

 

The following table sets forth the major components of non-interest income and expenses for the three months ended March 31, 2004 and 2003.

 

		Three Months Ended March 31
(In thousands)		2004			2003
Non-interest income:
Investment management and trust services		$	2,214		2,026
Service charges on deposit accounts		2,125			1,899
Bankcard transaction revenue		233			248
Gains on sales of mortgage loans held for sale		234			597
Brokerage commissions and fees		438			264
Other		443			475
Total non-interest income		$	5,687		5,509
Non-interest expenses:
Salaries and employee benefits		5,602			5,230
Net occupancy expense		706			572
Data processing expense		850			868
Furniture and equipment expense		270			232
State bank taxes		281			278
Other		1,889			1,899
Total non-interest expenses		$	9,598		9,079

 

Total non-interest income increased $178,000, or 3.2%, for the first quarter of 2004, compared to the same period in 2003.

 

Investment management and trust services income increased $188,000 or 9.3% in the first quarter of 2004, as compared to the same period in 2003.  Trust assets under management at March 31, 2004 were $1.25 billion, compared to $1.22 billion at December 31, 2003 and $1.05 billion at March 31, 2003.  Trust assets are expressed in terms of market value.  Assets under management are affected directly by the performance of the equity and bond markets and have been positively impacted by the positive performance that was seen in the first quarter of 2004 and the second half of 2003.  Also, the addition of new accounts continues to help grow assets under management.

 

Service charges on deposit accounts increased $226,000 or 11.9% in the first quarter of 2004 as compared to the same period in 2003. Growth in service charges on deposit accounts is primarily due to increased account volumes and an increase in the overall fee schedule for deposit accounts as compared to the prior year.  Continued growth in the Company’s market share and promotion of retail transaction accounts have resulted in more accounts and increased fee income.

 

Bankcard transaction revenue decreased $15,000 or 6.0% in the first quarter of 2004 as compared to the same period in 2003.  This source of revenue has been hampered by a 2003 class action lawsuit against VISA®USA and MasterCard® reducing interchange rates.  The reduction in interchange rates was effective in the third quarter of 2003 and increasing transaction volume has not been sufficient to offset declines in interchange rates.

 

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Gains on sales of mortgage loans were $234,000 in the first quarter of 2004 and $597,000 in 2003.  This represents a decline of 60.8%.  The Bank operates a mortgage banking division which originates residential mortgage loans and sells the loans in the secondary market.  Increases in long term interest rates led to a much lower level of activity beginning in the fourth quarter of 2003 and continuing during the first quarter of 2004.  For the first three quarters of 2003, long term interest rates were near their historic lows and led to a high level of refinancing activity.

 

Brokerage commissions and fees increased $174,000 or 65.9% in the first quarter of 2004 as compared to the same period in 2003. Improved performance of the overall equity markets and restored investor confidence allowed the brokerage department to report strong results for the first quarter.

 

Other non-interest income decreased $32,000 or 6.7% in the first quarter of 2004 and compared to 2003.  Numerous factors contributed to this decrease, but it was primarily the result of various fee income related to the mortgage company’s decreased volume.  Offsetting factors, though not as significant, were increases in fees on letters of credit and internet banking income.

 

Total non-interest expenses increased $519,000 or 5.7% for the first quarter of 2004 as compared to the same period in 2003.  Salaries and employee benefits increased $372,000, or 7.1%, for the first quarter of 2004 compared to 2003.  This increase arose in part from regular salary increases, as well as increased costs related to health insurance and other benefits.  Also, employees continue to be added to support the Bank’s growth.  The Bank had 392 full time equivalent employees as of March 31, 2004 and 372 full time equivalents as of March 31, 2003.  Net occupancy expense increased $134,000 or 23.4% in the first three months of 2004 as compared to 2003.  The increases are largely a result of the opening of new facilities, including three new branches since March 31, 2003, as well as new space occupied by the Company’s investment management and trust department in downtown Louisville.  Data processing expense decreased $18,000 or 2.0% for the first quarter of 2004 compared to 2003.  Furniture and equipment expense increased $38,000 or 16.4% for the first quarter of 2004 compared to 2003.  This increase is consistent with the increase in net occupancy expense and is a result of the expansion in the number of banking facilities.  State bank taxes were up $3,000 for the first quarter of 2004 compared to 2003.  Other non-interest expenses have decreased $10,000 or 0.5% in the first quarter of 2004 as compared to 2003.

 

Income Taxes

 

In the first quarter of 2004, Bancorp had income tax expense of $2,091,000, compared to $1,974,000 for the same period in 2003.  The effective rate for each three month period was 32.0% in 2004 and 32.3% in 2003.

 

(b)               Financial Condition

 

Balance Sheet

 

Total assets increased $16,242,000 from $1.118 billion on December 31, 2003 to $1.135 billion on March 31, 2004.  Average assets for the first three months of 2004 were $1.112 billion.  Total assets at March 31, 2004 increased $59,853,000 from March 31, 2003, representing a 5.6% increase.  Total liabilities increased $10,260,000 from $1.018 billion on December 31, 2003 to $1.028 billion on March 31, 2004.  Average liabilities for the first three months of 2004 were $1.008 billion.  Total liabilities at March 31, 2004 increased $43,602,000 from March 31, 2003, representing a 4.4% increase.

 

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Since year end, loans have increased approximately $7,217,000, mortgage loans held for sale increased $2,566,000 and fed funds sold increased $10,029,000.  This growth was funded primarily through the $30,000,000 increase in long term debt (fixed rate Federal Home Loan Bank advances) and offset by a decline in federal funds purchased.  The fixed rate advances from the FHLB are all non-callable, bullet maturities of three years or less and were used to replace higher priced certificates of deposit.  Management considers these advances from the Federal Home Loan Bank an attractive alternative to higher priced certificates of deposit.  Slow loan growth continues to reflect the lack of a meaningful rebound in business activity.  Additionally, new loan business has been somewhat offset by accelerated pay offs of existing business.

 

Non-performing Loans and Assets

 

Non-performing loans, which included non-accrual loans of $4,276,000 and loans past due over 90 days and still accruing of $309,000, totaled $4,585,000 at March 31, 2004.  Non-performing loans were $4,850,000 at December 31, 2003. This represents 0.51% of total loans at March 31, 2004 compared to 0.55% at December 31, 2003.

 

Non-performing assets, which include non-performing loans, other real estate and repossessed assets, if any, totaled $8,244,000 at March 31, 2004 and $8,483,000 at December 31, 2003.  This represents 0.73% of total assets at March 31, 2004 compared to 0.76% at December 31, 2003.

 

(c)                Liquidity

 

The role of liquidity is to ensure that funds are available to meet depositors’ withdrawal and borrowers’ credit demands while at the same time maximizing profitability.  This is accomplished by balancing changes in demand for funds with changes in the supply of those funds.  Liquidity to meet demand is provided by maturing assets, short-term liquid assets that can be converted to cash, and the ability to attract funds from external sources, principally deposits.  Management believes it has the ability to increase deposits at any time by offering rates slightly higher than the market rate.

 

The Bank has a number of sources of funds to meet its liquidity needs on a daily basis.  The deposit base, consisting of relatively stable consumer and commercial deposits, and large denomination ($100,000 and over) certificates of deposit, is a source of funds.  The majority of these deposits are from long-term customers and are a stable source of funds.  The Bank has no brokered deposits.

 

Other sources of funds available to meet daily needs include the sale of securities under agreements to repurchase and funds made available under a treasury tax and loan note agreement with the federal government.  Also, the Bank is a member of the Federal Home Loan Bank of Cincinnati (FHLB).  As a member of the FHLB, the Bank has access to credit products of the FHLB.  Additionally, the Bank has an available line of credit and federal funds purchased lines with correspondent banks totaling $88 million.

 

Bancorp’s liquidity depends primarily on the dividends paid to it as the sole shareholder of the Bank.  At March 31, 2004, the Bank may pay up to $31,182,000 in dividends to Bancorp without regulatory approval subject to the ongoing capital requirements of the Bank.  During the first quarter of 2004 the Bank paid dividends to Bancorp totaling $1,549,000.

 

(d)               Capital Resources

 

At March 31, 2004, stockholders’ equity totaled $106,396,000, an increase of $5,982,000 since December 31, 2003.  Accumulated other comprehensive income which for Bancorp consists of net unrealized gains on securities available for sale and a minimum pension liability adjustment,

 

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both of which are net of taxes, was $2,118,000 at March 31, 2004 and $1,474,000 at December 31, 2003.  The change since year end is a reflection of the effect of changing interest rates on the valuation of the Bank’s portfolio of securities available for sale.

 

S.Y. Bancorp Capital Trust I, a subsidiary of Bancorp, issued $20.0 million of 9.00% Cumulative Trust Preferred Securities in June 2001. The issue was sold in a public offering.  Bancorp used approximately $13.3 million of the net proceeds from this offering to reduce indebtedness outstanding under a line of credit with an unaffiliated bank.  The remaining net proceeds were used for making additional capital contributions to the Bank, for repurchases of common stock, and for general corporate purposes.  The trust preferred securities increased Bancorp’s regulatory capital and allow for the continued growth of its banking franchise.  The ability to treat these trust preferred securities as regulatory capital under Federal Reserve guidelines, coupled with the Federal income tax deductibility of the related expense, provides Bancorp with a cost-effective form of capital.  See note 4 to the consolidated financial statements for more information on the trust preferred securities which are now accounted for as subordinated debentures in Bancorp’s financial statements.

 

Bank holding companies and their subsidiary banks are required by regulators to meet risk based capital standards.  These standards, or ratios, measure the relationship of capital to a combination of balance sheet and off-balance sheet risks.  The values of both balance sheet and off-balance sheet items are adjusted to reflect credit risks.

 

At March 31, 2004, Bancorp’s tier 1, total risk based capital and leverage ratios were 13.92%, 15.20% and 11.10% respectively, compared to 13.09%, 14.36% and 10.05%, respectively, in the same period for 2003.  These ratios exceed the minimum required by regulators to be well capitalized.

 

(e)                Recently Issued Accounting Pronouncements

 

In January 2003, the FASB issued Interpretation No. 46 (revised December 2003), “Consolidation of Variable Interest Entities” (FIN 46) which addresses how a business enterprise should evaluate whether it has a controlling financial interest in an entity through means other than voting rights and accordingly should consolidate the entity.  FIN 46R is intended to achieve more consistent application of consolidation policies to variable interest entities and, thus improve comparability between enterprises engaged in similar activities even if some of those activities are conducted through variable interest entities.  Including the assets, liabilities, and results of activities of variable interest entities in the consolidated financial statements of their primary beneficiaries should provide more complete information about the resources, obligations, risks and opportunities of the consolidated enterprise.  For public companies, FIN 46R is applicable to all special-purpose entities (SPEs) no later than the end of the first reporting period ending after December 15, 2003 (i.e., December 31, 2003 for Bancorp), and immediately to all entities created after January 31, 2003.  The effective dates of FIN 46R vary depending on the type reporting enterprise and the type of entity that the enterprise is involved with.  FIN 46R permits either a cumulative effect adjustment or full restatement for all periods presented upon adoption of FIN 46R.  Bancorp has chosen a full restatement for its consolidated financial statements.

 

The only SPE that Bancorp has in place is a limited purpose trust that issues trust preferred securities.  These limited purpose trusts issue preferred securities to outside investors and use the proceeds of the issuance to purchase, from Bancorp, an equivalent amount of junior subordinated debentures having stated maturities.  The debentures are the only assets of the limited purpose trust.  When Bancorp makes its payments of interest on the debentures, the limited purpose trust distribute cash to holders of the trust preferred securities.  The trust preferred securities must be redeemed upon maturity of the debentures.  Prior to FIN 46R, Bancorp consolidated the limited

 

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purpose trust as a result of holding all the common equity of the limited purpose trust.  Under the requirements of FIN 46R, Bancorp must deconsolidate the limited purpose trust.  This has been reflected in Bancorp’s consolidated financial statements.

 

In December 2003, FASB issued SFAS No. 132 (revised), “Employers’ Disclosures about Pensions and Other Postretirement Benefits.”  SFAS No. 132 (revised) prescribes employers’ disclosures about pension plans and other postretirement benefit plans; it does not change the measurement or recognition of those plans.  SFAS No. 132 (revised) retains and revises the disclosure requirements contained in the original SFAS No. 132.  It also requires additional disclosures about the assets, obligations, cash flows, and net periodic benefit cost of defined benefit pension plans and other postretirement benefit plans.  SFAS No. 132 is generally effective for fiscal years ending after December 15, 2003.  Bancorp’s disclosures in Note 6 to the consolidated financial statements incorporate the requirements of SFAS No. 132 (revised).

 

In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Instruments with Characteristics of Both Liabilities and Equity,” which establishes standards for how an issuer classifies and measures certain financial instruments with the characteristics of both liabilities and equity.  SFAS No. 150 requires that an issuer classify a financial instrument that is within its scope, which may have previously been reported as equity, as a liability (or an asset in some circumstances).  This statement is effective for financial instruments entered into or modified after May 31, 2003, with certain exceptions, and otherwise is effective as of January 1, 2004, except for mandatorily redeemable financial instruments.  For certain mandatorily redeemable instruments, SFAS No. 150 will be effective on January 1, 2005.  The effective date has been deferred indefinitely for certain other types of mandatorily redeemable financial instruments.  Bancorp does not have any financial instruments that are within the scope of SFAS No. 150.

 

In March of 2004, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin 105, “Application of Accounting Principles to Loan Commitments,” (SAB 105) which provides guidance regarding loan commitments accounted for as derivative instruments under FASB Statement No. 133.  SAB 105 specifically addresses commitments to sell loans after funding and the fact that the commitment should be accounted for as a derivative instrument and measured at fair value.  SAB 105 is required to be applied to loan commitments accounted for as derivatives that are entered into after March 31, 2004.  The adoption of SAB 105 currently does not, and is not expected to have a material impact on Bancorp’s consolidated financial statements.

 

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Item 3.    Quantitative and Qualitative Disclosures about Market Risk

 

Information required by this item is included in Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

 

Item 4.    Controls and Procedures

 

Bancorp maintains disclosure controls and procedures designed to ensure that it is able to collect the information it is required to disclose in reports it files with the Securities and Exchange Commission (SEC), and to record, process, summarize and report this information within the time periods specified in the rules and forms of the SEC.  Based on their evaluation of Bancorp’s disclosure controls and procedures as of the end of the quarterly period covered by this report, the Chief Executive Officer, President and Chief Financial Officer believe that these controls and procedures are effective to ensure that Bancorp is able to collect, process and disclose the information it is required to disclose in reports it files with the SEC within the required time periods.  There has been no change in internal controls over financial reporting during the most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect those controls.

 

PART II – OTHER INFORMATION

 

Item 6.    Exhibits and Reports on Form 8-K

 

(a) Exhibits

 

The following exhibits are filed or furnished as a part of this report:

 

Exhibit Number		Description of Exhibit
31.1		Certifications pursuant to Section 302 of the Sarbanes-Oxley Act by David H. Brooks
31.2		Certifications pursuant to Section 302 of the Sarbanes-Oxley Act by David P. Heintzman
31.3		Certifications pursuant to Section 302 of the Sarbanes-Oxley Act by Nancy B. Davis
32		Certifications pursuant to 18 U.S.C. Section 1350

 

(b) Reports on Form 8-K

 

On January 23, 2004 Bancorp furnished a Form 8-K pursuant to Items 9 and 12 regarding the results of operations for the fourth quarter and year ended December 31, 2003.  Attached as an exhibit to such Form 8-K was a copy of a related press release dated January 22, 2004.

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

		S.Y. BANCORP, INC.
Date:	May 7, 2004	By:	/s/ David H. Brooks
			David H. Brooks, Chairman
			and Chief Executive Officer
Date:	May 7, 2004	By:	/s/ David P. Heintzman
			David P. Heintzman, President
Date:	May 7, 2004	By:	/s/ Nancy B. Davis
			Nancy B. Davis, Executive Vice
			President, Treasurer and Chief
			Financial Officer

 

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